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Know this about gloomy financial forecasts

2019-10-09, Michael Thompson

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Know this about gloomy financial forecasts

The intent of this article is to help you better handle dire economic news you will likely encounter. Ever since I've read investing news on the internet, a significant percentage of it has been from "experts" predicting doom and gloom in the following years. This scares many individuals into making sudden and drastic changes to their asset allocation - often to a more conservative portfolio that results in long term underperformance. A specific (extreme) example is provided below, followed by more information about these gloomy forecasts and some (hopefully) helpful facts.

Just for now!

Let's consider Steve, who started investing late 2006. He added roughly 1k USD to his S&P 500 investment each month. He suffered significant losses in 2008 and a subsequent boom. In 2013, after a few years of great performance, he decided he'd get even better. He started reading investment news and found a handful of experts warning of an upcoming crash. As usual, they cited true facts that were indeed disturbing. He sold half of his stock to buy gold and fixed income assets. He reasoned he'd sell these "safer" assets after a year or so and repurchase his stock at a lower price. A year turned into two, and then three until he finally rebalanced his portfolio in 2017, repurchasing his stock at a much higher price. In the meantime, Steve sacrificed a 56% return (an index fund left alone through that period) for a -10% return (that's right, minus as in less than 0%).

While this may be an extreme example, this general story has been lived by many people. Almost weekly someone tells me they are going to sell stocks when things start to look bad and repurchase when things look more attractive. I wish them luck but warn them about Steve and what I observed in 2008-2010. Most individuals I talked to sold regularly when the market was down in 2008 and bought back in at higher prices in 2009 and 2010. (Wealthy sharks did the opposite, buying stock while some were selling in fear.)

The message here: it would be great to sell stocks high and repurchase them at lower prices after a crash, but most individuals lower their returns in this endeavor.


As in Steve’s story, there are always "experts" predicting doom and gloom. If you search the web right now, you'll find expert articles predicting a major economic downturn (it doesn't matter if you read this now, a year after this writing, 10 years after or even 5 year before!). This has even been true over the last decade while the S&P 500 has grown over 350%! They often validate their conclusion by stating that they predicted the 2008 downturn (or some other event). With thousands of people predicting these things every year, some will indeed get it right. This does not imply they will get it right next time, however. Predicting these events is difficult and the best estimates (at least by the people controlling massive funds) are already baked into stock prices. People who buy and sell billions of dollars of these assets do their own research and sell large amounts of an asset – effective dropping its price – as soon as it gets "expensive" or risks crashing. Conversely, they buy it and increase the price when it's cheap. So, when you read one of these articles you can ask yourself this: should I believe the author knows more than the collective research behind trillions of USD of investment?

Another factor to consider here is the expert's motivation. For example, if you search the web right now you will find articles encouraging you to buy more gold. A significant portion of these articles are written by people in the business of selling gold (or an author funded by them). Beware of such conflicts of interest.

The message here: there will always be gloomy predictions, but only small fraction of them will be accurate.

What does gold do?

We’ll go into detail here about gold specifically. Why gold? Recently we've seen several individuals shift their portfolio to increase gold holdings after reading about the eminent collapse of fiat currencies. While some of these articles do cite some disturbing truths, we recommend you read some relevant wisdom below from Warren Buffett. Before that, let me clarify first that we are not implying you should sell all your gold (I myself have about 5% of my savings in gold).

In Berkshire Hathaway's 2011 shareholder letter, Buffett compared two investments: (1) the 9.6 trillion USD quantity of gold in the world to (2) all U.S. cropland plus 16 Exxon Mobile sized US companies plus 1 trillion USD cash. These were valued at equal amounts in USD at the time. After a century, he points out that the latter would produce staggering amounts of corn, wheat, cotton and other crops. The stocks will have produced trillions of dollars in dividends and hold assets worth trillions more. The gold will have produced nothing, it will still be a collection of shiny rocks. It's very hard to imagine this pile of rocks being valued above all the (more useful) goods produced by the 2nd investment.

In Berkshire’s 2018 letter Buffett points out that if, 77 years ago you'd foreseen the massive government deficits we've become accustomed to you might have panicked and opted to invest in gold rather than American business. As reward for foreseeing the deficits, you would have earned less than 1% of what you'd earned by an unmanaged investment in American stocks!

The message here: empirical evidence and logical arguments indicate that stocks should outperform gold long term.

What I’m not saying.

Just to be clear, I’m not saying you should invest all your money in stocks. Cash and other assets serve a useful purpose for most investors. What I am saying is to maintain an asset allocation appropriate for your situation. Significantly changing your allocations in reaction to "expert" warnings is a common point of failure.

Here's the summary.

For those who want to preach doom and gloom there's always justification. We live in a large, complex world with several threats to the economy. A small fraction of these threats will indeed be realized. At such times stocks may drop 20% or more while other assets like gold soar. However, it's unlikely you'll be able to time such events well enough to profitably dodge them (and you can waste a lot of time and money trying). If you plan to sell your stocks every time you read a dire prediction, you probably won't realize a good, long term investment return.

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